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27.09.2018Christine Daric, Olivier Mesmin

Tax Alert: Draft Finance Bill for 2019 – Reform of the French thin capitalization rules

The draft finance bill for 2019 was disclosed further to the Council of Ministers of 24 September. It contains a wide reform of the French thin capitalization rules. The reform would mainly consist in replacing the existing limitations by a global limitation of the deductibility of the net financial expenses capped to 30% of the EBITDA (Earnings Before Income Tax Depreciation and Amortization) of the concerned enterprise or 3M€. This new rule, in line with the ATAD Directive (Anti Avoidance Directive), is already the one applicable in Germany.

  • The current thin capitalization rules provided by Article 212 of the French tax Code (FTC) and which consist in analyzing the tax deductibility of interest relating to loans granted between companies belong to the same group or secured by a guaranty granted by a company belonging to the same group as the borrower, through the application of three ratios (amount of received/paid interest, 1.5 ratio of the net equity and 25% of the adjusted operating result) would be cancelled. The other rules would remain (limit of the rate and anti-hybrid provision).
  • All the financial expenses defined in a wide manner would be targeted by the text (see below).
  • Interests that are capitalized in the costs price of the property would no longer be outside the scope of French thin capitalization rules.
  • The interests which tax deductibility has been postponed and which have not been deducted yet at the closure of the FY preceding the 1st January 2019 would be subject to the new thin capitalization rules for their future tax deductibility.
  • The non-tax deductible financial expenses of a considered FY would become tax deductible on future FYs under the same conditions.

Please find below a summary of the rules which, if voted, would become applicable to FY open as from 1st January 2019 :

  • The net financial expenses would be tax deductible from the taxable result subject to French Corporate Income Tax (CIT) under the limit of the highest following amount :
    • Three millions euros, or
    • 30% of the taxable result adjusted by (i) net financial expenses such as the ones defined below, (ii) deducted depreciations, net of the taxable recaptures and of the part of the capital gain or loss corresponding to deducted depreciations, (iii) deducted impairments, net of taxable impairments, and (iv) certain gains or losses subject to CIT.
  • The net financial expenses would be defined as the excess of deductible financial expenses after the limit of the interest rate, compared to the taxable financial income and other equivalent incomes earned by the enterprise.
  • The definition of the financial income and expenses would be very wide and would correspond to the interest of any kind of debt, i.e. interest relating to the sums left or put at the disposal of the enterprise or by the enterprise including :
    • Payment relating to participating loans and obligations
    • Amounts paid in case of alternative financing
    • Interest capitalized in the acquisition price of the asset
    • Interest paid further to a derivative instrument or hedge
    • Foreign exchange gains or losses relating to debts
    • Guaranty costs relating to financing operations
    • ees relating to debts
    • Amount of rents in case of leasing, lease with an option to purchase or the rent of movable assets with a company placed under dependence link by virtue of Article 39-12 of the FTC
    • Any other costs or income similar to interests.
  • The company, which is member to a consolidated group could deduct 75% of the net financial expenses which are not considered as non-tax deductible if the ratio between its net equity and its whole assets is higher or equal to the same ratio computed at the level of its consolidated group.
  • The limitation of deduction of financial expenses would be hardened when interests are paid to a company having a dependent link with the borrower by virtue of Article 39-12 of the FTC  and which are deductible pursuant to the above-mentioned rule.
    • If these interests exceed the factor of their amount multiplied by a ratio between 1.5 time the net equity and the average amount of the sums put at the disposal by companies placed under the same dependent link, would be tax deductible within the limit of the highest of the two following amounts :
      • One million euros, or
      • 10% of the taxable result adjusted in the same way as mentioned above for the 30% limit.
    • Under this situation, the possibility to recover tax deductibility through the indebtedness ratio of the consolidated group would not be applicable.
    • The curing of this rule would not be applicable in the case of the cash pooling management nor in the case of a leasing.
  • The non-deducted financial expenses would become deductible up to an amount equal to the positive difference between the limit of deduction (the one of 3 M€/30% or 1M€/10%) and the net financial expenses of the FY. The net financial expenses which are not deducted pursuant to this rule could become deductible on tax results of future FYs under the same conditions. The capacity of unemployed deduction corresponding to the positive difference between the limit of deduction (the one of 3 M€/30% or 1M€/10%) and the deducted financial expenses could be used during the five following FYs to deduct financial expenses which are considered as non-tax deductible by application of the limit.
  • A decree would set the declarative obligations of the enterprises.
  • Particular rules would be applicable in case of tax consolidated group. In particular, the interest which deduction would have been postponed before the entry into a tax group could no longer be used as from the entry into the tax group of the company. The company would recover the possibility to deduct such postponed interest after the exit from the tax group.